The Concept of Variable Costing:

Variable costing charges products with only those manufacturing costs that
vary directly with volume. Only prime costs (direct materials and direct labor)
plus variable factory overhead expenses are assigned to inventories, both work
in process and finished goods, and to the cost of goods sold. Thus, these
variable costs are charged to the product while fixed manufacturing costs are
totally expensed in the current period. Manufacturing costs such as
depreciation, insurance, and taxes that are a function of time rather than of
production are excluded from the cost of the product. Also excluded are salaries
factory supervisors and office employees as well as wages of certain factory
employees, such as maintenance crews and guards, which are considered period
costs rather than product costs.

Direct costing focuses attention on the product and its costs. This interest
moves in two directories: (1) to internal uses of the fixed variable cost
relationship and the contribution margin concept; and to (2) to external uses
involving the costing of inventories, income determination, and financial
reporting. The internal uses deal with the application of direct costing in
profit planning, product pricing, other phases of decision making, and in cost
control. Executive management, including marketing executives, production
managers, and cost analysts, has generally praised, control, and analytical
potentialities of direct costing. Fixed costs calculated on a unit cost tend to
vary. On the other hand, direct unit costs and the contribution margin per unit
tend to remain constant for various volume of production and sales.

The
contribution margin or marginal income is the result of subtracting all
variable costs from sales revenue. In direct costing, an income per unit not
calculated; only an income on total sales of all products is determined by
subtracting the total fixed cost from the contribution margin.